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The Bear Case for General Electric

General Electric(NYSE: GE) stock has lost more than half of its value since the beginning of 2017. Nevertheless, some investors and analysts think the stock could continue to move lower.

In this episode of Industry Focus: Energy, the team digs into five key concerns that have been raised by GE bears. Some of the biggest worries relate to General Electric's balance sheet. The company has massive debt and pension liabilities, and its GE Capital financing unit has already taken two big charges in the past six months.

Sarah Priestley: There's so much negative sentiment around this company at the minute. If you type in "GE stock" into Google, the first five articles you're going to see are probably why you should sell GE. Can you summarize the bear case for GE right now?

Adam Levine-Weinberg: There are basically five key things that GE bears have pointed out. The first is the long-term struggles in the Power unit. The second is hidden liabilities at GE Capital, like that long-term care insurance subsidiary that caused the charge last year. The third is weak cash flow, especially in the near-term. The fourth is weak balance sheet. And then, the fifth one is that GE is just too complicated to manage.

To start with GE Power, as I mentioned a few minutes ago, that business is heavily focused on gas turbines for power plants. As the cost of renewable energy and energy storage has come down, that significantly reduced demand. These natural gas plants are often used as peakers to supply extra power when the grid needs a little more juice, particularly in the evening. If you have cheaper energy storage, then you can produce power at a steadier, and you don't need to pay for a whole extra power plant that only gets used a few hours a day.

On top of this demand issue, GE was also very slow to cut costs. That probably spoke to some organizational problems, where people were being over-optimistic about how fast [...] would bounce back. It took a while for GE to realize, no, this downtown is for real and it's not going to recover until at least 2020. That's the company's current outlook.

The second issue is that, in GE Capital, you've moved into all these areas like issuing subprime mortgages, and long-term care insurance, and a variety of other things that aren't actually related to GE's core industrial business. Those may have been profitable for a short period, but just as the long-term care insurance subsidiary came back to haunt GE a few months ago, now GE is preparing for, potentially, a big liability related to its mortgage activities, because like many other subprime lenders, it's potentially on the hook for penalties related to mortgage fraud, from selling these mortgages to investors without full disclosure.

No one really knows what else might turn up. Those are just the two things that people really know about. And this became a complicated financial subsidiary that, investors are certainly worried about whether there's other rocks that they haven't looked under yet, and in a year or two they'll find another $5 billion liability.

Priestley: [laughs] Yeah, I hope not. As an investor, I hope not.

Levine-Weinberg: Yeah. The third thing is cash flow. The problem is that Power and GE Capital are putting significant pressure on GE's cash flow. GE Capital in particular had been paying huge dividends to the parent company, the General Electric Corp subsidiary, for several years as it was selling off its assets. Now, it's decided that it can't pay any dividends because of this big charge it had to take, and it need to recapitalize. That's, right off the bat, a $2-4 billion headwind.

GE is also looking to spin off or sell various assets. As it sells assets, many of those assets are producing cash flow, so getting rid of them will reduce cash flow going forward. As a result, there are quite a few analysts out there who are at least worried that GE may have to cut its dividend again, even after having reduced it by 50% just six months ago.

Part of the reason why analysts are worried about cash flow is that the balance sheet is also pretty weak. GE had almost $126 billion of debt at the end of last quarter. It also had a fair amount of cash. But the net debt was still quite substantial. On top of that, the pension was underfunded by nearly $29 billion at the beginning of this year.

The high level, the last one, is just that all of these problems may indicate a broader problem of GE being too complicated to manage. The management team just hasn't been able to keep up, to keep the company performing at a high level.